Fed preparing to reduce balance sheet

• The minutes of the March FOMC meeting of the Federal Reserve revealed plans for how the Fed will run down its balance of roughly USD 9trn in assets, built up during the pandemic, and showed how policymakers are prepared to use large rate hikes to tackle the inflation pressures affecting the US economy. On the balance sheet, the Fed will run down assets at a pace of USD 95bn per month, with USD 60bn coming from Treasuries and USD 35bn from mortgage-backed securities. That is nearly twice as fast as the peak level the Fed used during its past period of quantitative tightening and the ramp-up period, how long it will take to get to that level, will be much shorter. The composition of the run-down looks like it will be made up of mainly Treasury bills and with the potential to sell MBS once the balance sheet has started to shrink.
• On the outlook for the Federal Funds rate, “many” officials supported using larger hikes to control inflation, according to the minutes of the March FOMC. That chimes with the pattern of Fed speakers in recent weeks who have come out in favour of 50bps hikes at upcoming meetings. The prospect of a 50bps hike at the May FOMC now looks more certain with larger hikes in June-July also in play. The Fed looks to be trying to get to its neutral rate or potentially above quickly which affirms the upside risks to our outlook for rates this year.
• DEWA, Dubai’s power and water utility, raised USD 6.1bn in its initial public offering in the largest regional IPO since the issuance of Saudi Aramco. DEWA priced 9bn shares at AED 2.48/share, at the top end of its pricing indication, a sign of strong demand for the shares with the total amount issued increased substantially from initial guidance. Total orders for the shares were around USD 86bn for a cornerstone stake in the Dubai economy.

Today’s Economic Data and Events

• 10:00 GE Industrial production Feb y/y: forecast 3.7%
• 16:30 US Initial jobless claims Apr 2: forecast 200k

Fixed Income

• The March FOMC minutes affirmed much of what the market had been expecting and had been preceded by comments from governor Lael Brainard earlier in the week. The impact on US Treasury markets was less substantial than may have been expected with the front end of the curve actually rallying over the day. The 2yr UST yield closed richer by 4bps, falling to 2.4714% while the 10yr added 5bps to settle at a yield of 2.5975%. The effects of the rundown of the Fed’s balance sheet will start to be felt in May with an official announcement coming at the May FOMC meeting.
• Bond markets in Europe closed lower overnight as the Fed minutes showed how far down the tightening path the Fed is compared with the ECB. Yields on the 10yr bund added 3bps during the day to settle at 0.644% while the 10yr gilt yield rose 5bps to 1.701%.

FX

• Despite the relative hawkishness of the Fed minutes, currency markets look to have already priced in much of the news and FX reaction was relatively contained. The dollar index closed up 0.13% at just shy of 99.60 as EURUSD dropped moderately to 1.0896 and USDJPY rallied to 123.80, up 0.16%. Sterling closed the day roughly flat at 1.3069.
• USDCAD moved up almost 0.5% as the Fed looks to be taking the edge on the Bank of Canada in terms of how quickly it will tighten policy. The pair settled up at 1.2544. AUDUSD fell almost 0.9%, wiping out all the gains recorded after the RBA indicated it was preparing tighten policy at its meeting earlier this week while NZDUSD fell 0.4% to 0.6918.

Equities

• Equity markets were once again weighed down by the prospect of more rapid tightening in the US, with the drawing down of the balance sheet squarely in focus as the minutes from the last FOMC meeting were released yesterday. In the US, the NASDAQ was once again the primary loser, dropping -2.2% as investors weighed up the risk to some of the more speculative growth stocks on the index. The Dow Jones lost -0.4% and the S&P 500 -1.0%.
• In Europe, the CAC lost -2.2%, with markets there increasingly concerned around the chance of an upset in the upcoming presidential election. Germany’s DAX dropped -1.9% and the UK’s FTSE 100 closed -0.3% lower.
• Locally, the DFM dropped -0.1% and the ADX -0.2%, while the Tadawul added 0.4%.

Commodities

• Oil prices dropped overnight as the market responded to an official plan from OECD countries to release 60m bbl from their strategic reserves, on top of the 180m bbl announced from the US last week. Brent futures settled down 5% to USD 101.07/b while WTI fell below USD 100/b, closing down 5.6% at USD 96.23/b.
• Data from the EIA showed a 2.4m bbl build in US commercial crude inventories last week while SPR stocks were down by 3.7m bbl. US production pushed up by 100k b/d to 11.8m b/d while product supplied was roughly stable at around 19.8m b/d.

Click here to download charts and tables